Posted in Strategy
By: Tom Gentile on August 19th, 2022 • 3 mins read
This is NOT going to be a discussion on when to take profits on stock holdings or investments as we are not Registered Investment Advisors, (RIA’s). Discussion on that matter is to be done between you and your broker/financial professional(s).
We are primarily options traders, and it is the topic of taking profits and managing losses of one’s options trades that we will provide our education and viewpoint on.
Setting Your Max Risk Per Option Trade
One can find an article in our archives on the subject Cost as Risk. It teaches our approach on the subject matter of how much to risk in one’s option trades.
In a nutshell, we offer the consideration of only risking 2% of one’s amount of money in their allocation to options trading. We use the example if a person has $25,000 take 2% of that or $500 and that would be the max risk in any one trade.
Then one can consider only ‘opening’ an option trade with the number of contracts that goes up to but does not exceed that $500. That way even in the worst-case scenario where one could lose 100% of the trade amount it is only the agreed upon ahead of time amount of $500 or 2% of options trading portfolio.
We are advocates of an approach for profit taking where when we get to a 100% gain in the trade to at least take off or close half the position.
This, of course, means one must have an equal amount of contracts otherwise consider partial or ALL of the trade at the 100% target.
If one closes half the position, the consideration / goal is to see if the other half can make another 100% and close the rest then.
Remember this is education on how we go about the process of trade management, and we are not recommending anyone do this. Even with options trading one needs to work with their brokers on what is deemed best for the account.
One of my support / educators likes to close it all at 100% gain if and when that happens. He says it’s like if he had a child that grows up to become a lawyer, he isn’t going to bust the child’s chops that the kid isn’t also a doctor.
The mindset is he is going to be happy with a level of success. And the level of success in options trading is 100% roi on the options trade(s).
If not 100% ROI Then What?
Not every trade is going to work out profitable. And definitely not all profitable trades will be at a 100% ROI.
Well then, at what dollar amount or percentage gain amount do you close?
One needs to ask themselves what amount of money or percentage gain is acceptable? When that amount gets hit that is when you consider closing the trade. OR…
Let’s say you get a 50% gain, and you are leaving the trade open to go for that 100% gain. One can consider having a trailing stop or at the least have a stop loss order at break even.
Discuss what you feel is appropriate with your broker and manage the affairs of that trade accordingly.
Look for a future educational piece on different types of stop orders, like what’s the difference between a stop loss and a stop limit in future articles.